Feldstein: the dollar must fall

The real trade-weighted value of the dollar must fall by at least 30% to halve the US trade deficit to a more sustainable level of 3% of GDP, writes Harvard's Martin Feldstein in today's Financial Times, Uncle Sam's bonanza might not be all that it seems (subscribers only). Mark Thoma provides us with the story and his comments:

Martin Feldstein: Capital Inflows Primarily from Foreign Governments, not Private Investors

Martin Feldstein says the optimistic view that capital inflows to the U.S. are the result of the attractiveness of investment is wrong and arises from a misinterpretation of the data. A proper interpretation of the data reveals that the source of capital inflows is primarily foreign governments, not foreign private investors. Furthermore, Feldstein says, "If they decide to buy fewer dollar bonds, the US current account deficit could not continue to be financed at current exchange rates and interest rates."

He believes a 30% decline in the dollar is necessary to get the current account down from 6% of GDP to a more sustainable level of 3% and that much larger changes are possible.  Finally, he says the only thing holding up the dollar currently is the belief that interest differentials that make U.S. financial investment attractive will persist. He adds, "That sanguine belief may, however, reflect a serious misunderstanding of the magnitude and nature of the capital flow to the US.".

Brad Setser has also posted on this piece: Martin Feldstein joins the dollar doomsday cult.

Stephen Kirchner take note. Alan Greenspan, too.  Dr. Feldstein thinks central banks -- and oil sheiks -- are behind a lot of private flows into the US.  And he doesn't seem convinced that this is will result in a stable equilibrium.  Not getting the Fed job does liberate one's oped pen.

No surprise, Dr. Feldstein's oped was music to my ears.  Not because he believes that a large fall in the dollar is needed to correct the current account deficit.  That is widely accepted, though the timing of the fall is fiercely debated.  But because it sometimes feels a bit lonely railing against the data that showed a huge surge in private inflows to the US in 2005.   That data never made much sense.  It doesn't show any flows from the oil exporters, and a country whose state owned oil company pumps oil for as little as $2 a barrel and sells it as $50 or $60 clearly has lots of cash to invest somewhere.  The fall off in central bank inflows into the US was a bit strange as well, given that there has not been a comparable falloff in global reserve accumulation.   

It is nice to have some of the arguments I have made backed by someone on the short-list to replace Alan Greenspan. I also would not underestimate the extent to which Dr. Feldstein's argument directly challenges some ideas central to Alan Greenspan's recent analysis of the US economy.

Finally, PGL at Angry Bear discusses a related point - the net income from abroad puzzle.

The fact that the trade deficit is more than 6% of GDP does not come as a surprise... But ..[one] has to wonder how a debtor nation avoids an ever widening debt/income ratio unless the present value of its expected future trade surpluses matches it current debt. Roubini and Setser note, however, that the U.S. has had a persistently positive net income from abroad position despite its net indebtednesses. We have mentioned this issue here and here.

It turns out that the CBO has addressed this puzzle here and here. The analysts consider a variety of explanations including the possibility that some of this puzzle is attributable to transfer pricing manipulation.